Will I Pay Less Tax If I Incorporate? 

In this article, Toronto business lawyer, Antonio DiMinno of DiMinno Rizzi Lawyers, answers the question: “Will I pay less tax if I incorporate?” 

Are you tired of seeing a significant chunk of your hard-earned income disappear into the black hole of personal income taxes? Imagine this: You’re a small business owner in Canada, and your personal income tax rate can skyrocket to a staggering 54% if you fall into the highest income bracket. But hold on to your financial hats because here’s where things get interesting. 

Incorporation, often overlooked and underestimated, is your secret weapon. Picture this: Instead of parting ways with $54 out of every $100 you earn, you could be holding on to $88, depending on your province and your business structure. That’s like putting your business on the express lane to success! 

Before you dive into the incorporation process, it’s a good idea to read this article.. In this article, Toronto business lawyer Antonio DiMinno will reveal the tax savings potential of incorporation.

How Much Tax Do I Pay When Incorporated?

Many of our clients often wonder, “How much tax do I pay when incorporated?” While your accountant is the best person to provide a precise answer, let’s take a look at the numbers to get a rough idea of the benefits of incorporation. 

Meet Sophia, who runs a real estate investing coaching business in Vancouver, British Columbia. Currently operating as a registered sole proprietorship, her business generates an annual revenue of around $200,000. Sophia incurs approximately $25,000 in business expenses each year, covering items like advertising and coaching materials. As a sole individual, she relies solely on the income from her coaching business. Her personal expenses, including rent, food, transportation, and essentials, add up to about $40,000 per year. 

If Sophia decides to go ahead with federal incorporation, her business would have an extra $14,291.00 available for reinvestment or withdrawal in a year with lower income tax, compared to her current tax situation. The savings of $14,291.00 in the first year as a corporation would not only cover the one-time incorporation fee but also continue to benefit her in the following years. 

Incorporation offers substantial tax savings that last year after year, with just a one-time incorporation cost. Moreover, it can provide you with other tax benefits such as a lifetime capital gains deduction, income splitting with family members in the business, and utilizing insurance and reorganizations to further reduce your tax burden. We delve into these additional tax advantages in our upcoming article, “What are the tax benefits of incorporating my business?” 

At DiMinno Rizzi Lawyers, we’ve incorporated businesses like Sophia’s in incorporating and saving substantial amounts in taxes over time. 

How Can I Save Taxes By Incorporating In Canada?

 
Once you’ve determined that incorporation can help you save on taxes, the next question is, “Will I pay less tax if I incorporate?” In simpler terms, will incorporating benefit my specific financial situation? 

In our experience, most of our clients end up paying fewer taxes after they’ve incorporated, even if their business income is less than $50,000.00. 

But it’s important to understand that incorporating may not always result in lower taxes. 

It’s crucial to grasp that when you operate as a corporation, there’s a corporate tax rate of 12% that applies. However, if you decide to withdraw the income left after paying corporate taxes as a salary, you’ll also be subject to personal income tax on that salary. 

Let’s consider Paul, the owner of a small property management company in Kitchener, Ontario. Paul’s company currently operates as a sole proprietorship and generates $150,000 in annual revenue. The yearly business expenses, including property maintenance, marketing, and office rent, total approximately $40,000. As an individual, Paul relies entirely on the income earned from his property management company to cover his personal expenses, which amount to around $30,000 per year. 

Now, if Paul chooses to incorporate a numbered company for his property management company, he’ll face a 12% corporate tax rate on the company’s profits. However, when he withdraws the income from the corporation as a salary, he’ll also be liable for personal income tax on that salary. 

So, while incorporation can offer potential tax benefits and savings, you’ll still need to consider taxes at both the corporate and personal levels. 

To learn more, check out our article, “How To Save Taxes by Incorporating a Business in Canada”

At What Income Level Should I Incorporate?

Many clients often ask, “At what income level should I incorporate?”  

Well, there’s no universal answer to this question. The response hinges on your company’s earnings and the amount you must withdraw as a salary for personal expenses. 

In our opinion, it’s not just about how much your business makes; the critical question is, “After corporate taxes, how much should I withdraw as a salary?” The more you leave within the corporation, the more you save on taxes! 

Now, let’s compare two examples: 

Example 1: Fred’s Auto Shop: Driving Tax Savings Through Incorporation 

Meet Fred, a client of DiMinno Rizzi Lawyers. Fred is a young entrepreneur who operates an auto repair shop. He earns $70,000 in profit from his Ottawa-based auto repair business. He faces a 12% tax rate on this income, amounting to $8,400 in taxes. Fred leads a modest lifestyle, sharing an apartment with three friends, and his annual living expenses total $15,000, which he withdraws as a salary. He pays approximately $1,000 in personal taxes on this $15,000, including $900 for CPP/EI premiums. In total, Fred’s tax obligation comes to around $9,400. 

After settling his taxes, Fred has approximately $47,000 left within his auto repair business, which he can reinvest or withdraw in a year with lower income. If DiMinno Rizzi Lawyers hadn’t assisted Fred in incorporating his auto repair business, he would have had to pay $17,100 in taxes. This translates to a significant tax savings of $7,700 in just one year! 

Example 2: “Greg’s Tax Dilemma: Balancing Business and Family Support” 

Now, let’s meet Greg, who owns a marketing consultant business in Toronto. His agency generates $200,000 in profit. Unfortunately, Greg allocates a significant portion of his earnings to child and spousal support costs, which are substantial due to his family circumstances. 

Greg’s company faces a 12% corporate tax rate on the $200,000 profit, leaving $176,000 within the corporation. However, to meet his obligations for child and spousal support, he withdraws the entire $176,000 as a salary. Greg ends up paying an additional $60,000 in personal income tax on this $176,000 salary, resulting in a substantial tax bill of approximately $84,000. 

Had Greg not chosen to incorporate, he would have been liable for about $71,000 in taxes. So, after incorporating, Greg finds himself paying $13,000 MORE in taxes this year, in addition to ongoing incorporation costs of $3,000 annually. In this scenario, Greg would have been in a better financial position without a corporation, considering his family support commitments. 

As you can see, there isn’t a specific income threshold where incorporation becomes the right choice. Indeed, in some instances, there can be disadvantages of incorporation. 

Your lawyer and accountant can provide valuable insights to help you decide whether you should incorporate.  

To make a better decision, check out our article, “At What Income Should I Incorporate in Canada?”

How A Toronto Incorporation Lawyer Can Help

As you can see, there isn’t a specific income threshold where incorporation becomes the right choice. It all hinges on how much money you withdraw from your business as a salary. Your lawyer and accountant can provide valuable insights to help you make the right financial decision. 

When considering incorporation, a crucial first step is to speak to an incorporation lawyer.

At DiMinno Rizzi Lawyers, we offer free consultations to learn about your business and discuss whether incorporation is the best decision for you. We’ll work closely with you to help clear the fog and ensure that your company is sailing in the right direction!